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Paying into a pension not only improves your long-term finances but could also help reduce your income tax. Here’s why.
10 March 2025 | 3 minute read
This article is for residents of England, Wales and Northern Ireland. If you live in Scotland, please click here.
Many of us know that saving into a pension is a great way of improving our long-term financial security. What is less well known is that pensions can also be a useful financial planning tool for those whose income puts them in a higher tax band.
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Pension and tax planning can be complicated, so it’s important to seek advice on what’s best for your individual circumstances. In the meantime, here are some of the main considerations.
Saving into a pension could be particularly tax efficient if your salary and/or bonus means you cross into a higher tax band. Assuming you have a standard personal allowance of £12,570, the income tax bands for England, Wales and Northern Ireland are as follows:
Income tax bands and rates 2024/25
Source: HM Revenue & Customs
Let’s imagine your total income is £55,270. You would pay 40% tax on the £5,000 of income that falls within the higher-rate tax band. If, however, you made a £5,000 gross pension contribution (£4,000 plus £1,000 tax relief) your ‘adjusted net income’ would fall to £50,270, potentially taking you out of the higher-rate tax bracket.
The same principle applies to the additional-rate tax band, which kicks in once your income exceeds £125,140. Income above this level is taxed at 45%, but you might be able to mitigate this by paying into a pension and lowering your adjusted net income to below the threshold.
Pensions could be an even more valuable financial planning tool for those earning more than £100,000 and whose personal allowance is tapered. The tax-free personal allowance reduces by £1 for every £2 your adjusted net income exceeds £100,000. It is nil once your income exceeds £125,140. The minimum tapered annual pension allowance is £10,000.
Although income that falls within the higher-rate band is taxed at 40%, the personal allowance taper means some of your income could effectively be taxed at a staggering 60%.
Let’s say you earn a £100,000 salary and are awarded a £1,000 bonus. Not only would you pay £400 in tax on the £1,000, but you would also lose £500 of your personal allowance. This extra £500 would also be taxed at 40%, costing you another £200. As a result, earning an extra £1,000 would cost you £600 in tax, which equates to a 60% effective tax rate.
One way to mitigate the so-called ‘60% tax trap’ is to save into a pension. If you made a gross pension contribution of £1,000, your adjusted net income would fall to £100,000, thereby reinstating your personal allowance and giving an effective rate of tax relief of 60% on your pension contribution.
Bear in mind that there’s a cap on the amount you and your employer can pay into your pension each year and still get tax relief. For most people, the pension annual allowance is 100% of your UK relevant earnings or £60,000, whichever is lower.
However, this might be tapered if your adjusted income exceeds £260,000. If you exceed your annual allowance, you’ll have to pay an annual allowance charge, which essentially claws back any tax relief received on the excess contribution. If you aren’t sure how much your annual allowance is, or you’re concerned about exceeding it, make sure you speak to a financial adviser.
Understanding pensions and tax and their impact on your overall finances can be bewildering, and that’s where getting some financial advice or speaking to a tax adviser can help.
An adviser will take a thorough look at your financial situation to determine whether making or increasing pension contributions suits your individual circumstances. They can also help you select the right pension fund for your needs, advise on other tax-efficient forms of investing, and keep on top of any changes to pension rules.
The value of investments, and any income from them, can fall and you may get back less than you invested. RBC Brewin Dolphin is not a tax specialist and this does not constitute tax advice. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. You should always check the tax implications with an accountant or tax specialist. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness.
This publication has been issued by RBC’s Wealth Management international division in the United Kingdom and the Channel Islands which is comprised of an international network of RBC® companies located in these jurisdictions and includes RBC Europe Limited and Royal Bank of Canada (Channel Islands) Limited. You should carefully read any risk warnings or regulatory disclosures in this publication or in any other literature accompanying this publication or transmitted to you by RBC’s Wealth Management international division.
This publication has been compiled from sources believed to be reliable, but no representation or warranty, express or implied is made to its accuracy, completeness or correctness. All opinions and estimates contained in this report are judgements as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. This report is not an offer to sell or a solicitation of an offer to buy any securities. Past performance is not a guide to future performance, the value of investments and income arising can go down, future returns are not guaranteed, and an investor may not get back the amount originally invested. Countries throughout the world have their own laws regulating the types of securities and other investment products and services which may be offered to their residents, as well as the process for doing so. As a result, any securities or services discussed in this report may not be eligible for sale in some jurisdictions. This report is not, and under no circumstances should be construed as, a solicitation to act as a securities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealer in that jurisdiction. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investment advice.
This material is prepared for general circulation and does not have regard to the particular circumstances or needs of any specific person who may read it. The investments or services contained in this report may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about the suitability of such investments or services. To the full extent permitted by law none of the entities which comprise the international division of RBC Wealth Management nor any of their affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. No matter contained in this document may be reproduced or copied by any means without the prior consent of RBC Wealth Management.
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